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October 2019 Investment Commentary

A choppy third quarter produced flat world stock performance, and roughly flat portfolio returns, with solid year-to-date gains maintained. July’s tranquil conditions and modest gains ended abruptly on August 1st, with President Donald Trump’s tweet vowing to tariff the more consumer-oriented $300 billion piece of imports from China.  Over the balance of the quarter, the markets were presented with a number of additional challenges. This included an attack on Saudi Arabia that temporarily shut down almost 6% of the world’s oil production, political upheaval in the U.K. around Brexit, a postponement of a high-profile stock offering, and finally, the beginnings of an impeachment proceeding against President Trump. Meanwhile, the economic outlook continued to slide moderately, particular softness showing in manufacturing and trade output, directly related to the ongoing U.S.-China dispute.  

  Third Quarter Year to Date  Five Years (ann.)
World Stocks 0.0% 16.2% 6.7%
S&P 500 1.7 20.6 10.8
Emerging Markets -4.2 5.9 2.3
Developed International Stocks -1.1 12.8 3.3
Global Bonds 0.9 6.6 2.2
Global Hedge Funds 1.6 5.9 0.3
Commodities -1.8 3.1 -7.2

While trade rhetoric eased later in the quarter and hopeful eyes turned to the next round of negotiations this month, the impact became more apparent.  U.S. imports from China, which were $540 billion in 2018, mainly computers, cell phones, apparel and related items, dropped 12% in the first seven months of 2019.  Chinese imports from the U.S., which were $120 billion in 2018, mainly commercial aircraft, soybeans, and cars, dropped 28% over the same seven-month period.  So, while our trade deficit was reduced by roughly $30 billion, about $100 billion in overall commerce between the two countries was lost.  The latest development, our black-listing of 28 Chinese companies preventing them from buying U.S. components, would inflate this total.  Robert Horrocks of Matthews Asia, one of our investment managers, said it well: “A trade war is really like two duelers standing apart, facing each other, and shooting themselves in the foot.”

On this backdrop, the World Trade Organization on October 1st sharply cut its forecast for global trade growth, from 2.6% to 1.2% in 2019, and from 3.0% to 2.7% in 2020.  While the U.S.-China skirmish presumably could create opportunity for other countries, the overriding factor so far has been the dispute’s unpredictability.  With global companies unsure of the rules of the road, the uncertainty has cast a pall on the activities of most exporting economies. The International Monetary Fund (IMF) has estimated that this will shave 0.8% from 2020 global GDP growth, from 3.5% to 2.7%.  On a base of $88 trillion in world GDP this year, that would be a very big hit, several multiples of the $100 billion seven-month direct trade volume loss between the U.S. and China.  Manufacturing readings are bearing this out already, including the U.S., which in September reported the worst output since June 2009, the final month of the last recession.

For now, economic growth seems to have settled into the 2.0-2.5% range that we’ve become so accustomed to over the last ten years. A brief spike to 3.5% in the second quarter of 2018, directly related to the late 2017 passage of the Tax Cut and Jobs Act (whose main feature was a cut in corporate tax rates from 35% to 21%), quickly receded to 2.9% and then 1.1% over the two subsequent quarters.  Similarly, corporate capital spending, averaging dull low to middle digit growth over the last five years, enjoyed a brief post tax cut surge to 9% in 2018 before fading to a projected 2% rate in 2019.  Following a 2.0% second quarter of 2019, U.S. economic output heads into the year’s final months seemingly maintaining about that pace.  The growth engine continues to be the well-employed consumer, and this raises the stakes for ongoing employment growth.  The September jobs report essentially kept this trend intact, with tapered gains but also a further reduction in the unemployment rate by two tenths to 3.5%, a number last seen at the end of 1969.

With late cycle economic concerns continuing to smolder, the third quarter offered signs of a valuation reality check on the part of investors, offering parallels to the end of the party almost 20 years ago.  This was evidenced by a disconnect between the private and public markets, notably concerning We Co., of WeWork office space sharing fame.  Having been valued as high as $47 billion at the time of its last private funding raise, the company, whose revenues were almost matched by its losses, encountered a far rougher reception by public investors, recently scrapping an initial offering that would have transacted at a valuation of closer to $10-15 billion.  Further, the two well-known ride-sharing companies going public this year, Lyft and Uber, trade at respective discounts of 20% and 30% to their final private valuations.

The reality check theme is sure to apply across public markets, in keeping with the time of year.  This happens in autumn for the simple reason that the succeeding year has drawn close, and all guidance has to be fine-tuned.  Equity returns may depend on whether we see signs of a break-out from what has been a dull phase of quarterly earnings.  Following a modestly negative first quarter, earnings fears were eased a bit by close to 4% growth in the second, helped by strength in health care, real estate and financials.  Estimates thus are now around 5% for 2019 as a whole, and in the low double digits for 2020.  The latter may prove optimistic.  One potential boost, perhaps next year, is a restoration of capital spending, including not only deferred outlays but also ramped up investments in digital payments and 5G mobile communications, among other emergent technologies.  A more permanent-feeling resolution of the trade war would help.   

As 2019 winds down, various political developments will be sure to occupy investor headspace.  The September 14th missile strike on Saudi Arabia and its primary oil facility jolted markets and pushed oil prices up 14.7% on the first trading day.  Making good on early predictions, however, the Saudis were able to restore output to pre-attack levels within three weeks, and prices more than retraced their gain.  It will undoubtedly take a bit longer to sort out the political, if not military, state of affairs, still lacking clarity on exactly where the button was pressed, how the attack was carried out, and why Saudi and local U.S. air defense systems were so exposed.  With Iran involved either directly or by proxy (Houthis, a less likely scenario), the American response may need to go beyond sanctions, but deference to the Saudis appears to be the current setting.

In Europe, two key events are scheduled at month-end.  European Central Bank head Mario Draghi’s eight-year term closes, with a handover to former IMF head Christine Lagarde.  This comes at a sensitive time as there has been more open resistance to extreme monetary ease and negative interest rates.  Lagarde is not expected to bring a new hard line, but may make a stronger push for stimulative fiscal spending in countries where deemed detrimentally thrifty, most notably Germany.  Halloween also will force some type of resolution, probably not a permanent one, on the Brexit front.  With Boris Johnson hobbled by parliamentary rebuke and rejection by the E.U., a hard, final break, including new customs controls on the Northern Ireland border, seems unlikely. Other scenarios including a change in leadership and possible new referendum also are in play.  Deep-seated complexities abound, and this will not go quietly.

Decibel levels also are elevated in Washington, now the setting of an impeachment action.  Market implications are as inchoate as the President’s fate, either via this process or an election just over a year away.  Theories are rife as to whether this will hurt Joe Biden and thus elevate a more progressive, market-unfriendly agenda (including speculation that an Elizabeth Warren administration could pursue even tougher China policy, with sanctions prompted by the treatment of Hong Kong protesters).  This in turn could benefit President Trump, his message and re-election prospects further enhanced by a Senate acquittal.  The twists and turns will matter to the extent that they carry economic and investment implications.  Markets, waiting on a new NAFTA and other pending measures, probably would not look kindly on protracted agenda distraction at the hands of an impeachment process.

The outlook may be a bit more uncertain and indeed darker, but we continue to feel a recession can be avoided in the near term, with any downturn being relatively shallow.  How markets respond is never determinate, but it could be argued that a recession would be preferable to a 1-2% GDP holding pattern, after some market-clearing pain.  The latter can include shake-outs that weed out weaker companies, and provide a fresh baseline from which to build new investment, spending, and hiring programs.  At the moment, however, most cyclical indicators – auto sales, residential investment, durable goods spending, among others – are close to or under 50-year averages, thus not seemingly poised for a major fall.

As for portfolio positioning, we have modestly trimmed hedged U.S. equity commitments and redeployed the proceeds into long-only U.S. equity, including both active and low-cost passive exposure.  Total equity allocations thus remain intact.  While we could well see continued spikes in volatility and investor angst such as occurred in August, and electoral dynamics will heat up as the calendar requires, we feel President Trump will not want to see a trade war-induced recession.  Any solid resolution would free up corporate managers to recalibrate and reactivate supply chains and commerce.  If on the other hand we do see severe trade and economic deterioration, investors may begin to look toward a new administration.  As always, we could counsel further allocation changes in the months and quarters ahead.

We wish all of you the best and thank you for your continued support.  We will be back as events require, but feel free to reach out in the meantime.


David S. Beckwith, CFA

Managing Director & Chief Investment Officer


This letter may include forward-looking statements.  All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”).  Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct.  Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.